Last week, I was invited by Bureau van Dijk in London for a presentation at a conference with the theme of modern credit risk management at international level.
What should we present to an audience of dozens of credit manager ? Also discussing with the head of BvD in Brussels, I thought the best thing would be to show what the main difficulties that a credit risk manager should face are when he/she has to evaluate companies around the world, and how we can help him.
Here you can find the presentation that I did, and now I want to summarize it.
The main difficulties arise from the fact that the credit manager should evaluate a wide variety of standards of information each day. Having a job that involves information on companies operating in various states, the problems arise from:
- Diversity in the financial statements filing standards: practically we are talking about the fact that in the world there are different accounting standards (the best known are Continental ones based on Earnings Before Interest, Taxes, Depreciation and Amortization- EBITDA and the Anglo-Saxon ones based on Gross profit for income statements). The credit manager needs to know in detail about the different standards and succeed in a fast and efficient way to understand everything and bring coherence to its evaluation.
- Diversity in the business environments in which businesses operate: (different countries and different sectors), this means that the credit manager must understand for example, if the Return on Equity- ROE of 7% has the same meaning in terms of profitability success for a company operating in the commercial sector in Italy and a company operating in the construction sector in Turkey (of course, and unfortunately for the credit manager, this is not really possible).
- We know that the credit manager has not always all financial statement details at his disposal: There are both legal reasons (e.g. in the UK, the lack of income statements for small size companies) and reasons of unavailability of financial data (e.g. in Asia), as the financial statements are not always complete. For both cases, our poor credit manager must be able to understand the level of counterparty risk, and make it consistent with the states where are all of the information.
It might seem an impossible job and extremely complex, and indeed it is. But luckily there are also technical processes to address them. In fact, you can develop,-and we, modeFinance we did it with the MORE credit rating model - models of credit risk assessment that address all of these issues in order to obtain a model of risk that allows the credit manager to deal with his job more easily and get a consistent assessment in different states. The important thing though is to have a model to follow some important guidelines:
- A model that is not based on machine learning which considers implicit diversity between healthy companies and bankrupt companies: the “holes ” in the financial statements of foreign Bankrupt companies makes this kind of models impractical.
- Not a single model but different models, for each country and for each sector in the world, the differences among countries and among sectors are huge and to adopt a single model is a fundamental error .
- Remember that there are two different accounting items. Beware, there is EBITDA and there is Gross Profit and they are not the same thing!
- Studying deeply different states, the model should behave as a senior analyst of the state where the company operates; without this knowledge, the risk assessment would fail.
With a rating model that follows these guidelines, the credit risk manager will have provisions for a tool that will help him in his work every day, getting the best out of all available information.